How to Calculate the Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio helps businesses understand how effectively they manage the credit extended to customers. This financial metric indicates how many times a company collects its average accounts receivable balance over a specific period, typically a year. It provides insight into the efficiency of a company’s credit policies and its overall accounts receivable management practices.

Key Financial Figures Needed

To calculate the accounts receivable turnover ratio, two primary financial figures are necessary: net credit sales and average accounts receivable. Each component offers a distinct view into a company’s sales and collection activities.

Net credit sales represent the revenue generated from sales where customers are granted credit. This figure is derived from a company’s gross credit sales, adjusted by subtracting any sales returns, allowances, or discounts provided to customers. For instance, if a customer returns a product, that value reduces the original credit sale amount. This information is typically found on a company’s income statement, often within the revenue or sales section, though it may require a manual calculation if not explicitly listed as “net credit sales.”

Average accounts receivable measures the typical amount of money owed to a business by its customers over a specific period. It is calculated by adding the accounts receivable balance at the beginning of the period to the balance at the end of the period, and then dividing that sum by two. For example, if a company’s accounts receivable was $50,000 on January 1st and $70,000 on December 31st, the average accounts receivable would be $60,000. These balances are found on the company’s balance sheet.

Performing the Calculation

Once the necessary financial figures are identified, calculating the accounts receivable turnover ratio involves a straightforward division. The formula for this ratio is Net Credit Sales divided by Average Accounts Receivable.

To apply the formula, take the net credit sales figure and divide it by the average accounts receivable figure. For example, consider a company with net credit sales of $1,200,000 for the year. If its average accounts receivable for the same period was $150,000, the calculation would be performed by dividing $1,200,000 by $150,000.

In this example, the accounts receivable turnover ratio would be 8. This indicates that the company collected its average accounts receivable eight times during the year.

Understanding the Calculated Value

The numerical result of the accounts receivable turnover ratio provides a direct insight into a company’s collection frequency. A higher ratio signifies that a company collects its accounts receivable more frequently throughout the period. This suggests an efficient process in converting credit sales into cash.

Conversely, a lower ratio indicates that a company collects its receivables less frequently. This means it takes a longer time, on average, for the company to convert its credit sales into cash. The ratio therefore acts as a measure of how quickly a business rotates its receivables. The calculated value directly reflects the number of times, on average, the accounts receivable balance has been collected and replenished during the measured timeframe.